Tax Implications for Selling Business Property

Selling your business premises or other business assets is a significant financial event and one that comes with tax implications. Understanding the tax implications before the sale is crucial for maximizing your returns and avoiding potential pitfalls.

Various tax considerations will shape the way you sell business property and get the best out of your commercial real estate investments. Explore concepts like capital gains taxes, depreciation recapture, and installment sales with a tax professional to help you optimize your financial position.

Tax Rules When Selling Business Property

You can expect to pay federal capital gains taxes and, if applicable, state income taxes or capital gains taxes when you sell a business property.

According to the Internal Revenue Code, the gains and losses you incur from selling business property that you have held for more than 12 months (long-term) are netted against each other. The resulting net gain or loss is subject to the following tax treatment:

1. If the sale of your property results in a net gain, the sale will be subject to long-term capital gain taxes and depreciation recapture rules. 
2. If the sale of your property results in a net loss, you can deduct up to $3,000 of the loss against your ordinary income. Depreciation recapture rules do not apply if the sale results in a loss.

Business Property Recapture Rule

Businesses commonly purchase property for work use. In this case, “property” covers anything from a computer to heavy machinery or real estate.

In many cases, you can either gradually (or sometimes immediately) write off the cost of business property through depreciation deductions. While this can boost your bottom line during the property's useful life, claiming deductions comes with a catch. You may be liable to pay depreciation recapture tax when you sell the property.

It's important to be aware of depreciation recapture when selling property as many business owners who aren't aware of it are then stung by a higher-than-expected tax bill.

What Is Depreciation Recapture?

Depreciation recapture occurs when the IRS claims back some of the depreciation deductions a business has received on property it is now selling. Recapture treats a portion of gains as regular income rather than as a capital gain. This is significant as ordinary income tax rates are higher than long-term capital gains tax rates. This prevents a business from receiving two tax breaks—depreciation deductions and then lower tax rates—on the same business property.

Depreciation Recapture for Real Estate Property vs Non-Real Estate Property

The treatment of depreciation recapture differs depending on whether the asset you sell is real estate or non-real estate property. Depreciation recapture on non-real estate property will be taxed at the individual income tax rate. 

The rules for real estate are a little more complicated. While any gains beyond the original cost basis are taxed as capital gains, the part related to depreciation is taxed at the Section 1250 tax rate. This is capped at 25%. 

Calculating Depreciation Recapture

When you sell an asset for more than its adjusted basis (original cost minus depreciation), the difference is considered a gain. However, a part of that gain (equal to the depreciation you claimed) will be recaptured as ordinary income.

Here's a simplified breakdown of the calculation:

1. Determine the adjusted basis: This is the original cost of the asset minus any depreciation deductions taken.
2. Calculate the gain: Subtract the adjusted basis from the sale price to determine the total gain.
3. Identify the recapture amount: The recapture amount is the lesser of the total gain or the accumulated depreciation.
4. Tax implications: The recapture amount is taxed at your ordinary income tax rate, while the remaining gain (if any) is taxed at the capital gains tax rate.

Example:

• Original cost of equipment: $10,000
• Accumulated depreciation: $4,000
• Adjusted basis: $6,000
• Sale price: $8,000
• Gain: $2,000
• Depreciation recapture: $2,000 (since it's less than the accumulated depreciation)

In this example, $2,000 would be taxed at your ordinary income tax rate, and the remaining $0 would be taxed at the capital gains tax rate.

Long-Term Capital Gains Tax Rates

The long-term capital gains tax brackets for 2024 are listed in the following table. Earnings over the maximum 15% rate are taxed at 20%.

Filing Status	Maximum Zero Rate Amount	Maximum 15% Rate Amount
Married Individuals Filing Joint Returns and Surviving Spouse	$94,050	$583,750
Married Individuals Filing Separate Returns	$47,025	$291,850
Heads of Household	$63,000	$551,350
All Other Individuals	$47,025	$518,900
Estates and Trusts	$3,150	$15,450

Source: Internal Revenue Service, "Revenue Procedure 2023-34."

Some states also impose state capital gains taxes while others like Florida (where our Jacksonville office is located) enjoy a 0% state capital gains rate.

Strategies to Reduce Capital Gains Taxes

Capital gains taxes can significantly impact the proceeds from selling business property. The good news is that some strategies could potentially reduce your tax liability. Get professional help from experts in real estate accounting services to ensure you take advantage of every tax benefit available to your business.

1. Time the Sale Strategically

The timing of the business property sale can significantly affect how much you pay in capital gains taxes. Holding onto the asset for more than a year qualifies you for long-term capital gains tax rates.

You can also reduce your tax burden by strategically setting the transfer of ownership of your property to a year where you expect a lower tax burden. The IRS website clarifies that net capital gain is taxed at 0% if your taxable income is less than or equal to $44,625 for single and married filing separately, $89,250 for married filing jointly or qualifying surviving spouse, or $59,750 for head of household.

You can also offset capital gains with capital losses from other investments to reduce your overall tax burden. Though no business would wish to incur capital losses, the silver lining is that they can be used to reduce the tax burden of capital gains.

2. 1031 Exchange

A 1031 exchange allows the deferral of the payment of capital gains taxes on business property as long as another "like-kind" property of equal or greater value is then purchased. While it's true that the 1031 doesn't avoid capital gains taxes—only deferring payment until the second property is sold—avoiding taxes in the present can be highly advantageous.

For example, some businesses or investors exchange properties indefinitely and acquire increasingly profitable business property. At the same time, they defer capital gains taxes.

Section 1031 states that when property held for business or investment purposes is sold, the owner or business has 45 days to find a replacement property. The deal must then be closed within 180 days of the original sale.

3. Installment Sale Strategy

Taking a lump sum payment for your property isn’t always the most favorable option tax-wise. Accepting payment for your property in installments over different tax years allows sellers to declare a prorated part of their capital gains over several years. This strategy may be effective in cutting your capital gains tax bill.

Be aware that many rules and regulations surround installment sales. A tax professional can help you avoid mistakes and optimize your tax savings when using this strategy.

4. Invest in Opportunity Zones

The Opportunity Zones program offers a way to defer capital gains taxes until December 31, 2026. This is contingent on the business or investor reinvesting their money into an Opportunity Fund. An Opportunity Fund is an investment vehicle that must invest at least 90% of its assets in properties or qualified businesses in one of the 8,700 Qualified Opportunity Zones around the country.

Strategy Is Key When It Comes to Capital Gains Taxes

Selling business property comes with significant and sometimes complex tax implications. Understanding the nuances of capital gains taxes, depreciation recapture, and other relevant tax rules is crucial for maximizing your after-tax proceeds.

Proactive tax planning is essential to optimize your tax liabilities. A tax professional can arm you with effective legal strategies to defer or reduce taxes when the time comes to sell your business property.